It’s a Partnership! No, It’s an LLC! No, It’s Both!
July 24, 2017
In 1981, three partners formed a general partnership to own and operate a rental property. Their partnership agreement fixed a 30-year term, to 2011. In 2003, the partners formed a new LLC maintaining the same ownership percentages as the partnership, to which the partnership transferred the property for purposes of refinancing the existing mortgage loan.
In 2016, after failing to secure a buy-out agreement, the holder of a 45% interest sued to dissolve the LLC under New York LLC Law § 701 (a) based on the 2011 expiration date in the partnership agreement.
But wait, you say, didn’t the LLC supersede the partnership and, if so, how can the LLC’s duration be governed by the termination date in the partnership agreement? Unless there’s an LLC agreement that provides otherwise, isn’t the LLC’s existence perpetual by default? And how can the owners hold themselves out to the world as an LLC while acting as partners among themselves? After all, it was the mortgage lender that likely required the transition from partnership to LLC as a condition of the loan, among other reasons, precisely to avoid the risk associated with a general partner’s unfettered right to dissolve the partnership at any time for any reason.
An interesting set-up, indeed, for a decision last week by Manhattan Commercial Division Justice Saliann Scarpulla in Golder v 29 West 27th Street Associates, LLC, 2017 NY Slip Op 31527(U) [Sup Ct NY County July 17, 2017], in which she denied a motion to dismiss the dissolution petition upon finding “a material issue of fact exists as to whether a written operating agreement exists as to the LLC’s term of duration.”
I think you’ll agree the outcome makes more sense after I throw in some additional facts from the dissolution petition (read here) and the parties’ evidentiary submissions.
The petitioner alleged that in 2003, the managing partner requested his consent, which he gave, to “transform” the partnership to an LLC in connection with a proposed mortgage refinancing, as evidenced by the managing partner’s letter (read here) stating that “the current ownership and partnership known as 29 West 27th Street Associates will now be known as 29 West 27th Street Associates, LLC with the same partners and partners interests” (emphasis added).
The petitioner further alleged that he never was shown or asked to consent to an operating agreement for the newly formed LLC, and that it was understood and intended that “the terms contained in the Partnership Agreement” — including the 2011 termination provision — “would continue, insofar as now governing the operation of the LLC, which would, for all intents and purposes, operate in an identical way as the partnership had done.”
The respondents countered with the LLC’s 2003 operating agreement — apparently drawn up concurrently with the refinancing — appointing one of the respondents as sole managing member and providing for the LLC’s “perpetual duration.” The agreement, however, was not signed by the petitioner. The respondents sought to minimize the absence of petitioner’s signature by pointing to the formal consent he also signed in 2003, giving the LLC’s managing member blanket authority “to act on behalf of the company in the execution of documents and instruments” in connection with the refinancing.
Two additional pieces of evidence submitted by the petitioner, both dating from 2015, likely contributed to Justice Scarpulla’s finding of a material issue of fact concerning the LLC’s termination date. The first was a May 2015 letter from the LLC’s managing member to petitioner, discussing a plan to renovate one of the property’s units. The letter starts out, “Pursuant to our conversation and the partnership agreement . . .” and closes with the statement that the “necessary consent” to proceed with the renovation has been obtained “according to our partnership agreement.”
The second was a series of emails later that year in which, in response to the petitioner’s demand for financial records of the LLC “under the terms of the Partnership Agreement,” the managing member agreed to provide quarterly statements pursuant to “a review of the Partnership Agreement” which, in fact, required the preparation and delivery of quarterly financial reports to each partner — a feature not found in the LLC operating agreement.
One of my very first posts on this blog many years ago (read here) discussed the Hochberg case in which the court similarly found a question of fact whether an arbitration clause and buy-sell provisions in a partnership agreement for a dental practice remained operative after the partners converted the partnership to a professional corporation. Essentially, the court ruled that such pre-conversion agreements are enforceable as long as the rights of creditors or other third parties are not involved and the parties’ rights under the partnership agreement are not in conflict with the corporation’s functioning.
Which raises the question yet to be answered in Golder, whether the members of the LLC formed in 2003 could continue to live by and enforce among themselves the terms of the 1981 Partnership Agreement, including its limited durational existence, consistent with the LLC’s mortgage lender’s reliance on the borrower’s organizational form and its adoption of a written operating agreement providing for its perpetual duration.
Another potentially important issue awaiting further developments in Golder is whether, in accordance with LLC Law § 402 (c) (3) as construed earlier this year by an appellate court in Shapiro v Ettenson, the respondents holding a majority of the membership interests could bind the petitioner to the LLC’s operating agreement providing for perpetual duration notwithstanding he never signed it.
A related question, weighing against the respondents, is whether their alleged failure to disclose or even to mention the 2003 operating agreement to the petitioner for over a decade, and their communications with petitioner extending into 2015 in which they refer to the Partnership Agreement as the governing document, estop them from denying its enforceability.
With unanswered questions like these, I smell a buy-out settlement in the offing.
Update January 18, 2018: Justice Scarpulla’s above-described order directed an evidentiary hearing to be conducted before a Special Referee to determine whether the LLC’ s members entered into a written operating agreement setting forth a perpetual duration. The hearing was held before a Special Referee who, after hearing argument by counsel and without taking any sworn testimony, found that the petitioner never agreed to, or ratified, any operating agreement and that the initial partnership agreement and its 2011 termination date applies. You can read the 18-page transcript here. Currently pending are the parties’ dueling motions to confirm and to reject the Special Referee’s report and recommendation.
Update June 13, 2018: In a Decision and Order dated June 7, 2018 (read here), Justice Scarpulla confirmed the Special Referee’s report and ordered the LLC’s dissolution based on the 2011 expiration date in the Partnership Agreement.